FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 3, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from______________to_________________
Commission File Number 0-18655
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THE FAILURE GROUP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 77-0218904
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(State or other jurisdiction of incorporation) (I.R.S. Employer
Identification Number)
149 COMMONWEALTH DRIVE, MENLO PARK, CALIFORNIA 94025
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (650) 326-9400
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X No
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Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at November 3, 1997
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Common Stock $.001 par value 7,417,539 shares
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE FAILURE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
OCTOBER 3, 1997 AND JANUARY 3, 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
OCTOBER 3, 1997 JANUARY 3, 1997
(Unaudited)
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ASSETS
Current assets:
Cash and cash equivalents........................................ $ 5,369 $ 4,465
Short-term investments........................................... 5,465 20,271
Accounts receivable.............................................. 28,963 19,710
Prepaid expenses and other assets................................ 5,435 4,927
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Total current assets........................................... 45,232 49,373
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Property, equipment and leasehold improvements, net............... 29,584 28,789
Other assets...................................................... 10,900 2,416
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$85,716 $80,578
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities......................... $ 3,444 $ 4,047
Notes payable and current installments of long-term obligations.. 1,248 1,250
Accrued payroll and employee benefits............................ 6,354 5,590
Income taxes payable and deferred income taxes................... 1,138 928
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Total current liabilities...................................... 12,184 11,815
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Long-term obligations, net of current installments................ 17,284 18,505
Deferred income taxes............................................. 987 987
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Total liabilities.............................................. 30,455 31,307
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Stockholders' equity:
Common stock..................................................... 8 8
Additional paid-in capital....................................... 33,007 33,013
Net unrealized gain on investments............................... 23 56
Retained earnings................................................ 25,035 21,644
Treasury shares, at cost; 582,729 and 1,096,659 shares at
October 3, 1997 and January 3, 1997, respectively.............. (2,812) (5,450)
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Total stockholders' equity.................................... 55,261 49,271
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$85,716 $80,578
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The accompanying notes are an integral part of these condensed consolidated
financial statements.
THE FAILURE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE QUARTERS AND NINE MONTHS ENDED OCTOBER 3, 1997 AND SEPTEMBER 27, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Quarters Ended Nine Months Ended
(Unaudited) (Unaudited)
------------------------ ------------------------
October 3, September 27, October 3, September 27,
1997 1996 1997 1996
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Revenues
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Professional fees.................... $19,340 $11,711 $49,667 $36,539
Equipment fees and billed expenses... 675 1,138 4,081 3,941
Other revenue........................ 163 146 490 374
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$20,178 $12,995 $54,238 $40,854
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Operating expenses
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Compensation and related expenses.... 12,538 7,975 33,591 24,694
Other operating expenses............. 3,728 3,151 10,290 9,259
General and administrative expenses.. 1,961 1,248 4,927 3,813
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$18,227 $12,374 $48,808 $37,766
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Operating income................... 1,951 621 5,430 3,088
Other income and expense
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Interest Expense, net................ (359) (384) (855) (1,102)
Misc. Income, net.................... 529 411 1,552 1,168
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170 27 697 66
Income from continuing operations.... 2,121 648 6,127 3,154
before income taxes
Provision for income taxes 859 263 2,481 1,277
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Income from continuing operations.... $ 1,262 $ 385 $ 3,646 $ 1,877
and before extraordinary item
Discontinued operations
Income (loss) from operations
of PLG............................ $ (155) $ 10 $ (144) $ 110
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Income before extraordinary item... $ 1,107 $ 395 $ 3,502 $ 1,987
Extraordinary item
(net of taxes of $301)............ $ -- $ -- $ -- $ (443)
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Net income......................... $ 1,107 $ 395 $ 3,502 $ 1,544
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Income per share from continuing
operations........................ $ 0.17 $ 0.06 $ 0.51 $ 0.28
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Discontinued item per share............. $ (0.02) $ -- $ (0.02) $ 0.02
======= ======= ======= =======
Income per share before
extraordinary item................ $ 0.15 $ 0.06 $ 0.49 $ 0.30
======= ======= ======= =======
Extraordinary item per share............ $ -- $ -- $ -- $ (0.07)
======= ======= ======= =======
Net income per share.................... $ 0.15 $ 0.06 $ 0.49 $ 0.23
======= ======= ======= =======
Weighted average number of
common shares..................... 7,593 6,720 7,113 6,640
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The accompanying notes are an integral part of these condensed consolidated
financial statements.
FAILURE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED OCTOBER 3, 1997 AND SEPTEMBER 27, 1996
(IN THOUSANDS)
NINE MONTHS ENDED
(Unaudited)
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OCTOBER 3, SEPTEMBER 27,
1997 1996
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Cash flows from operating activities
Net income, (before discontinued operation and extraordinary item for
1996)..................................................................... $ 3,646 $ 1,434
Adjustments to reconcile net income to net cash provided by operating
activities
Depreciation and amortization............................................. 2,710 2,892
Provision for doubtful accounts........................................... 201 1,459
Discontinued operations................................................... (144) 110
Extraordinary item, net of retirement of debt (net of taxes $301)......... - 443
Changes in operating assets and liabilities
Accounts receivable....................................................... (6,541) (2,422)
Prepaid expenses.......................................................... (810) 421
Accounts payable and accrued liabilities.................................. (1,478) (280)
Income tax receivable..................................................... - 2
Accrued payroll and employee benefits..................................... 120 138
Income taxes payable and current deferred income tax...................... 210 -
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Net cash provided by operating activities................................. (2,086) 4,197
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Cash flows from investing activities
Capital expenditures...................................................... (2,835) (2,305)
Acquisition of PLG, Inc................................................... - (501)
Acquisition of EHS, Inc................................................... - (250)
Acquisition of BCS, Inc.................................................. (314) -
Acquisition of PTI, Inc.................................................. (7,495) -
Purchase of short-term investments........................................ (4,557) (8,076)
Sales of short-term investments........................................... 19,300 3,681
Other assets.............................................................. 169 8
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Net cash used by investing activities..................................... 4,268 (7,443)
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Cash flows from financing activities
Proceeds from borrowings and issuance of long-term obligations............ 6 18,262
Repayments of borrowings and long-term obligations........................ (1,429) (18,684)
Net purchases of common stock............................................. - (1,024)
Net issuance and retirements of common stock.............................. 145 322
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Net cash used by financing activities..................................... (1,278) (1,124)
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Net (decrease) increase in cash and cash equivalents...................... (904) (4,370)
Cash and cash equivalents at beginning of period.......................... 4,465 7,401
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Cash and cash equivalents at end of period................................ 5,369 3,031
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The accompanying notes are an integral part of these condensed consolidated
financial statements.
THE FAILURE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL QUARTERS AND NINE MONTHS ENDED OCTOBER 3, 1997
AND SEPTEMBER 27, 1996
NOTE 1: BASIS OF PRESENTATION
The Failure Group, Inc. ("FGI" and, together with its subsidiaries, the
"Company") is a multidisciplinary organization providing engineering consulting,
scientific investigation and information support services. The Company operates
on a 52-53 week fiscal calendar year ending on the Friday closest to the last
day of December.
The accompanying condensed, consolidated financial statements are prepared
in accordance with generally accepted accounting principles and include the
accounts of FGI and its subsidiaries. All significant intercompany transactions
and balances have been eliminated in consolidation. In the opinion of
management, all adjustments which are necessary for the fair presentation of the
condensed consolidated financial statements have been included and all such
adjustments are of a normal and recurring nature. The operating results for the
quarter and nine month period ended October 3, 1997, are not necessarily
representative of the results of future quarterly or annual periods.
Administrative compensation expense which had been included in general and
administrative expenses has been reclassified to compensation and related
expense. Additionally, bad debt expense which had been included in other
operating expense is now included in general and administrative expenses.
Prior year numbers have been restated to conform with the current year
presentation.
NOTE 2: DISPOSITION OF OPERATIONS
On September 18, 1997, the Company sold its PLG, Inc. ("PLG") subsidiary to EQE
International, Inc. EQE has agreed to pay approximately $2.0 million in
quarterly installments (plus interest at 10% annum), through March 18, 1999,
with unamortized principal of approximately $1.0 million due and payable with
the final quarterly installment, subject to certain post-closing adjustments.
PLG was operating near breakeven with an annualized revenue run rate of
approximately $5.0 million at the time of divestiture. The sale of PLG has been
included in the accompanying, condensed, consolidated financial statements as
discontinued operations. No gain or loss has been recognized from this
disposition.
NOTE 3: ACQUISITIONS
On August 1, 1996, the Company acquired all of the outstanding capital stock of
Environmental Health Strategies, Inc., ("EHS") for a combination of cash and
stock. On January 4, 1997 the Company acquired all of the outstanding capital
stock of Broadcast Communication Systems, Inc. ("BCS"). The results of
operations of these acquisitions have been included in the accompanying,
condensed, consolidated financial statements from the date of their acquisition.
The inclusion of these acquisitions are considered immaterial, and thus separate
disclosure is not provided. These collective purchases are herein referred to
as the "Acquired Businesses".
On April 28, 1997, the Company announced the signing of a definitive agreement
to acquire Performance Technologies, Incorporated, d.b.a. PTI Environmental
Services ("PTI"), a privately-held environmental science and engineering firm.
The acquisition was consummated on May 16, 1997, whereby FGI acquired all of the
stock of PTI for approximately $7.5 million in cash and 480,002 shares of stock
valued at approximately $2.4 million. The acquisition was accounted for under
the purchase method of accounting and, accordingly, the purchase price was
allocated to the net assets acquired based on the estimated fair market value at
the date of acquisition. The Company recorded approximately $7.2 million as
goodwill,
which reflects the excess of the purchase price over the fair value of the net
assets acquired. The goodwill will be amortized over twenty years using the
straight-line method.
The results of operations of PTI have been included in the accompanying
condensed, consolidated financial statements from the date of acquisition.
Results of operations for year-to-date ended October 3, 1997, assuming the
Company and PTI were combined at the beginning of that period, would have been
as follows (in thousands, except per share data):
Nine Months Ended
October 3, 1997
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Revenues $58,887
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Net income $ 3,675
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Net income per share $ 0.52
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The Acquired Businesses and PTI are collective referred to herein as the
"Acquisitions".
NOTE 4: RECENT ACCOUNTING PRONOUNCEMENTS
In January 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128, "Earnings Per
Share". SFAS 128 requires the presentation of basic earnings per share ("EPS")
and, for companies with complex capital structures or potentially dilutive
securities, such as convertible debt, options and warrants, diluted EPS. SFAS
No. 128 is effective for the annual and interim periods ending after December
15, 1997. The Company expects that basic EPS will be higher than primary
earnings per share as presented in the accompanying condensed consolidated
financial statements and that diluted EPS will not differ materially from fully
diluted earning per share as presented in the accompanying condensed
consolidated financial statements.
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income". This
Statement establishes standards for reporting and displaying comprehensive
income and its components in the financial statements. It requires that a
company classify items of other comprehensive income, as defined by accounting
standards, by their nature (e.g., unrealized gains or losses on securities) in a
financial statement, but does not require a specific format for that statement.
The Company is in the process of determining its preferred format. The
accumulated balance of other comprehensive income is to be displayed separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. This Statement is effective with the fiscal 1998 financial
statements. Reclassification of financial statements for earlier periods
provided for comparative purposes is required.
In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information". The Statement requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments on the basis that is used internally for
evaluating segment performance and deciding how to allocate resources to
segments. This statement is effective with the year-end 1998 financial
statements. Comparative information for interim periods in the initial year of
application, 1998, is to be reported in the financial statements for interim
periods in the second year of application, 1999.
NOTE 5: SUPPLEMENTAL CASH FLOW INFORMATION
The following is supplemental disclosure of cash flow information, in
thousands.
Nine Months Ended
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October 3, 1997 September 27, 1996
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Cash paid during the period:
Interest $ 947 $1,713
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Income taxes $ 2,092 $1,030
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Noncash investing activities:
Disposition of operations:
Net working Capital $(1,172) --
Property, equipment & leasehold
improvements, net (264) --
Other assets (458) --
Notes Receivable 2,104 --
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the attached
unaudited, condensed, consolidated financial statements and notes thereto and
with the Company's audited consolidated financial statements and notes thereto
for the fiscal year ended January 3, 1997, which is contained in the CompanyOs
1996 Annual Report.
GENERAL
The Company derives most of its revenues from professional service activities.
Revenues from professional services are mostly derived under "time and expenses"
and "fixed-fee" billing arrangements, and are recorded as work is performed.
Professional fees are a function of the total number of hours billed to clients
and the associated hourly billing rates or fixed-fee arrangement with the
client. The Company also derives revenue from equipment fees and net billed
expenses which consist primarily of fees charged to clients for use of the
Company's equipment and facilities in connection with services provided. Other
revenue is generated primarily from photographic services. The Company's
principal expenses are professional compensation and related expenses.
RESULTS OF OPERATIONS
1997 fiscal quarter and nine months ended October 3, 1997 compared to 1996
fiscal quarter and nine months ended September 27, 1996
Revenues for the 1997 third quarter increased by 55% to $20.2 million, as
compared to $13.0 million for the third quarter of 1996. Additionally, revenues
for the first nine months in 1997 increased 33% to $54.2 million as compared to
$40.9 million for the comparable period of the prior year. These increases were
partially a result of the inclusion of the Acquired Businesses totaling $1.5
million for the 1997 third quarter and $4.0 million on a year to date basis.
Additionally, the acquisition of PTI contributed $3.4 million in revenues for
the third quarter of 1997 and $5.1 million for the nine months ending October 3,
1997. Excluding the Acquisitions, revenues for the third quarter increased 20%
over the same quarter of the prior year and 11% on a year-to-year basis.
Professional fees for the third quarter and first nine months of 1997 increased
65% and 36%, respectively, from 1996. Third quarter professional fees revenues
were $19.3 million compared to $11.7 million for the same period of the prior
year, while year-to-date professional fee revenues were $49.7 million for 1997
compared to $36.5 million for 1996. These revenues include $1.5 million of
Acquired Business revenues for the quarter and $4.0 million of revenues year-to-
date combined with $3.9 million of PTI quarterly
revenues and $4.8 year-to-date revenues. Excluding these revenues, professional
fees for the third quarter and year-to-date increased by 22% and 13%,
respectively, as a result of an increase in billable hours.
Equipment fees and net billed expenses declined by 41% to $675,000 for the third
quarter of 1997 as compared to $1.1 million for the third quarter of 1996.
Excluding equipment fees for PTI, quarterly equipment fees increased 8%, but the
year-to-date fees decreased 4%. Equipment fees were 4% higher than the
comparable year-to-date period in the prior year, escalating to $4.1 million
from $3.9 million. This decrease was a result of a decline in the usage of the
Company's software and database equipment.
Compensation and related expenses increased by 57% to $12.5 million in the third
quarter of 1997 compared to $8.0 million for the same period in 1996.
Compensation and related expenses from the Acquired Businesses contributed
$928,000, while PTI contributed $2.2 million. Excluding the Acquisitions,
compensation increased 20% over the same quarter of the previous year, which
was attributable to higher headcount and a Company-wide salary increase, which
took effect in April 1997, plus higher overtime due to higher billable hours.
Compensation, as a percentage of total revenues, excluding the effect of the
Acquisitions, remained flat at 62% for the third quarter of 1997 and 1996.
Compensation and related expenses for the first nine-month period ending October
3, 1997 and September 27, 1996, increased 36% to $33.6 million for 1997 from
$24.7 million for 1996. Excluding compensation from the Acquired Businesses of
$2.4 million and PTI's compensation of $3.3 million, these expenses increased
14% over the comparable nine month period, resulting from a Company-wide salary
increase and from an increase in headcount. Compensation and related expenses
excluding the Acquisitions represented 62% of total revenues for the first nine
months of 1997 compared to 60% for the first nine months of 1996.
Other operating expenses in the third quarter and first nine months of 1997
increased 18% and 11%, respectively. This increase for the quarter included
$248,000 of the Acquired Businesses operating expenses and $495,000 of PTI
expenses. Year-to-date, there were $621,000 of Acquired Businesses expenses, and
$744,000 of PTI expenses. Excluding the Acquisitions, other operating expenses
for the quarter and year-to-date were $3.0 million compared to $3.1 million, and
$8.9 million compared to $9.3 million, respectively. These decreases on a
quarterly and yearly comparison over the prior quarter and year can be
attributed to a decline of 16% and 14%, respectively, in computer expenses and a
15% and 27%, respectively, decline in depreciation expense as a result of
replacing the Company's accounting software. Other operating expenses,
excluding the Acquisitions were 20% and 25%, respectively, of total revenues for
the third quarter of 1997 and 1996 and 20% and 23% for the first nine months of
1997 and 1996.
General and administrative expenses ("G&A") in the third fiscal quarter of 1997
were $2.0 million as compared to $1.2 million for the same period of the
previous year. This amount included $307,000 of Acquired Businesses G&A
expenses, plus $408,000 of PTI G&A expenses. Excluding the Acquisitions, G&A
remained constant to the comparable quarter in 1996. G&A expenses excluding the
Acquired Businesses represented 8% of total revenues for the third quarter of
1997 and 9% for the third quarter of 1996. For the first nine months of 1997,
G&A increased 29% to $4.9 million as compared to $3.8 million for the
corresponding period in 1996. Excluding the $795,000 of Acquired Businesses G&A
expenses, plus $595,000 of PTI expenses, the 6% decrease was primarily
attributable to a decline in bad debt expense and a decrease in marketing
expenses as a result of cost cutting measures. G&A expense, excluding the
Acquisitions, represented 8% of total revenues for the first nine month period
in 1997 as compared to 9% for the comparable period of 1996.
Other income (expense) consisted primarily of interest expense on the Company's
mortgage obligation, net of investment income earned on available cash and
short-term investment and rental income from leasing excess space in the
Company-owned operating facilities located in Menlo Park, California. Included
in other income (expense) was a $35,000 gain and a $30,000 loss from sales of
marketable securities in 1997 compared to a $7,000 gain and a $23,000 loss in
1996. The primary changes in other income (expense) for the third quarters and
the first nine-month periods of 1997 and 1996 were derived from higher rental
income and lower interest expense due to refinancing the building mortgage
offset by reduced investment income as a result of a decline in short-term
investments due to the acquisition activity.
In August 1996 the Company refinanced its building mortgage which held a 10.75
percent fixed rate note, amortized on a 30-year basis with the balance due in
1999, to the new note in the amount of $18.7 million, having a 15-year term
with a floating rate tied to LIBOR. This note is collateralized by the building
and the rate is subject to adjustment every six months. In February and August
of 1997 the Company made a principle payments on the note in the amount of
approximately $600,000 each.
LIQUIDITY AND CAPITAL RESOURCES
1997 fiscal quarter and nine months ended October 3, 1997 compared to 1996
fiscal quarter and nine months ended September 27, 1996
Net cash used by operating activities was $2.1million in the first nine months
of 1997 compared to net cash provided of $4.2 million for the comparable period
in 1996. This decrease in cash provided by operating activities can be
attributable to higher outstanding accounts receivable compared to the prior
year due to increased revenues and the impact of the Acquisitions. Accounts
receivable represented 115 days of revenue at October 3, 1997 compared with 111
days at September 27, 1996.
Net cash provided by investing activities for 1997 was $4.3 million as compared
to net cash used by investing activity of $7.4 million for 1996. This increase
was a result of the sales of short-term investments, partially offset by the
cash used for acquisition activity.
Net cash used by financing activities was $1.3 million for the first nine months
of fiscal 1997 compared to $1.1 million in the comparable period of fiscal 1996.
The decline in cash used over the prior year was a result of the Company
repurchasing 177,000 shares of its common stock in 1996, compared to no stock in
1997, offset by the principal paydown of the Company's mortgage.
At October 3, 1997, the Company had $5.4 million in cash balances, $5.5 million
in short-term investments and a $10.0 million line of credit agreement renewed
in August of 1997. There have been no borrowings against this line of credit in
1997. The Company's long-term obligations on October 3, 1997, consisted
primarily of a mortgage obligation for the Company's office facility in the San
Francisco area in the amount of $17.4 million which was refinanced as of August
1, 1996. (See "Results of Operations" for the details of the refinancing).
Management believes that its existing cash and short-term investment balances,
together with existing bank credit facilities and funds generated from
operations, will provide adequate cash to fund the Company's anticipated cash
needs through at least the next twelve-month period.*
*Designates a forward-looking statement within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results could differ from
those referred to in the forward-looking statement because of a number of risks
and uncertainties, including a downturn in business, increased competition, loss
of key personnel and the failure of the Company to secure contract for the
Company's services.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
On May 16, 1997 the Company issued 480,002 shares of its Common Stock in
connection with the acquisition of PTI as described in the Company's Current
Report on Form 8-K, as amended, filed with the Securities and Exchange
Commission (the "Commission") on May 30, 1997. The issuance of the Common Stock
was deemed to be exempt from registration under the Securities Act of 1933, as
amended (the "Act"), in reliance on Section 4(2) of the Act and Rule 505 of
Regulation D promulgated under the Act. In such transaction, the recipients of
the Common Stock represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the securities
issued in such transaction.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The information required by this item is incorporated by reference to Item 4 of
the Company's Quarterly Report on Form 10-Q for the quarter ended July 4, 1997.
Items 1, 3, and 5 of Part II are not applicable and have been omitted.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE FAILURE GROUP, INC.
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Registrant
Date: November 14, 1997 /s/ Michael R. Gaulke
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Michael R. Gaulke, President and CEO
Index to Exhibits
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Exhibit
Number Description of Document
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11.1 Statement Regarding Computation of Net Income
Per Share
27.1 Financial Data Schedule